The announcement of the widely anticipated increase in the UK’s main rate of interest and the Bank’s prediction of an earlier and longer than previously forecast recession, has coincided with news of a decline in construction output for the first time since January 2021.
The Bank of England yesterday increased Bank Rate by 0.5 percentage points to 1.75%, in what was its largest interest rate hike since 1995. It also forecasts that the UK will enter recession in the fourth quarter of the year, not next year as it had previously stated.
Inflation is now expected to rise from 9.4% in June to over 13% in the fourth quarter of the year. It is expected to remain high throughout 2023, not falling to the 2% target for two years.
A rate increase had been expected, in particular because of the rising cost of energy, but the negative message was further underlined by the S&P Global/CIPS UK Construction PMI figures for July which indicated a reduction in UK construction output for the first time in 18 months.
“With inflation running at historically high levels, this [interest rate] increase was widely expected,” said William Scoular, head of private client lending, Investec Real Estate.
“Whilst further dampening demand in certain parts of the property market, we expect the residential sector to remain robust, underpinned by the continued imbalance of demand outstripping supply,” he said.
Inflation cycle ‘not traditional’ and harder to predict
Marcus Phayre-Mudge, fund manager at TR Property said that while property portfolio income can be relatively inflation proof where rents are linked to national inflation, making central bank decisions relatively neutral, he said the difficulty for markets is that “this is not a traditional inflation cycle, it is being influenced hugely by geopolitics which markets often struggle to interpret and correctly price.”
However, Phayre-Mudge added that much of the bad news is already priced in. “Any glimpse of a solution to the problems in Ukraine would be taken very positively,” he said.
The news was not universally negative in the S&P Global/CIPS UK Construction PMI. There was an increase in commercial construction work, but this was at its weakest level for 18 months and more than offset by the lower volumes of residential work and civil engineering activity, the survey report said.
Martin Beck, chief economic advisor to forecasting group EY ITEM Club, said that the construction PMI’s decline to 48.9 from 52.6 the previous month was below the survey’s 50 no-change threshold for the first time since January 2021 and pointed to the fastest decline in output since May 2020.
“A decline in the construction index in July joined falls in the same month’s services and manufacturing PMIs,” Beck said. “However, the latter two remained above the 50-mark, signalling continued, if sluggish, growth in activity. So, on the basis of the PMIs, construction is the weakest of the economy’s major sectors.”
He added that PMIs (purchasing managers indexes) can sometimes paint an overly gloomy picture of the economy’s performance during times of heightened economic uncertainty.
“As such, the latest readings should be interpreted cautiously. And there were some bright spots in the latest construction survey: the recent fall in the price of some commodities contributed to input costs faced by the sector rising at the slowest pace since March 2021; and supplier delays were the least widespread since February 2020.”
However, he added that the pressure of energy price increase on building firms as well as higher interest rates and reduced spending power owing to inflation indicated that the weakness will continue and EY ITEM Club expects a slowdown across the economy for the rest of this year and into 2023.